Appendix B

Japanese Technology and Efforts to Rebuild U.S. Commercial Shipbuilding: The Newport News Shipbuilding-Ishikawajima Harima Heavy Industries Alliance

BACKGROUND

Rapidly changing political and economic environments are causing many U.S. defense firms to alter their approach to technology acquisition and cooperation. As they seek to enter new markets and offset the decline in revenues from defense contracts, American companies are faced with strong international competition and have become increasingly interested in foreign technology.

One such firm is Newport News Shipbuilding and Drydock Company, a leading builder of naval vessels. Founded in 1886 and now part of the Tenneco conglomerate, this Virginia-based firm has approximately 20,000 employees and annual revenues of $2.2 billion. Newport News has been largely dependent on government contracts for nuclear-powered aircraft carriers and submarines. In recent years, however, declining military acquisitions have necessitated a rethinking of the firm ’s future. In an effort to consolidate the defense industrial base, for example, the U.S. Department of Defense (DoD) eliminated Newport News as a producer of submarines. Future requirements for aircraft carriers are uncertain, but carrier procurements by themselves clearly will not provide sufficient long-term support to the company. As a direct result of these and other defense cuts, Newport News laid off some 4,000 employees (15 percent of the total work force) in 1992-1993.

In this environment, foreign military sales and diversification into commercial markets have come to be seen as the keys to Newport News ’ future business, and the firm is reorienting to pursue these goals. An extensive analysis of global commercial shipbuilding markets was undertaken, as was a survey of foreign manufacturing capabilities and techniques. In addition, consultants were hired to determine ways in which the shipyard could improve its operating procedures. Newport News managers believe that this program of market and technology research will pay off in coming years by improving the competitiveness of the firm and enhancing its ability to diversify into new markets.

LIQUIFIED NATURAL GAS TANKER MARKET

A cornerstone of the diversification effort has been a drive to enter the liquified natural gas (LNG) tanker market. LNG tankers began operating in the mid-1960s, and approximately 100 ships are currently in service worldwide. LNG tankers are extremely complex vessels, and



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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force Appendix B Japanese Technology and Efforts to Rebuild U.S. Commercial Shipbuilding: The Newport News Shipbuilding-Ishikawajima Harima Heavy Industries Alliance BACKGROUND Rapidly changing political and economic environments are causing many U.S. defense firms to alter their approach to technology acquisition and cooperation. As they seek to enter new markets and offset the decline in revenues from defense contracts, American companies are faced with strong international competition and have become increasingly interested in foreign technology. One such firm is Newport News Shipbuilding and Drydock Company, a leading builder of naval vessels. Founded in 1886 and now part of the Tenneco conglomerate, this Virginia-based firm has approximately 20,000 employees and annual revenues of $2.2 billion. Newport News has been largely dependent on government contracts for nuclear-powered aircraft carriers and submarines. In recent years, however, declining military acquisitions have necessitated a rethinking of the firm ’s future. In an effort to consolidate the defense industrial base, for example, the U.S. Department of Defense (DoD) eliminated Newport News as a producer of submarines. Future requirements for aircraft carriers are uncertain, but carrier procurements by themselves clearly will not provide sufficient long-term support to the company. As a direct result of these and other defense cuts, Newport News laid off some 4,000 employees (15 percent of the total work force) in 1992-1993. In this environment, foreign military sales and diversification into commercial markets have come to be seen as the keys to Newport News ’ future business, and the firm is reorienting to pursue these goals. An extensive analysis of global commercial shipbuilding markets was undertaken, as was a survey of foreign manufacturing capabilities and techniques. In addition, consultants were hired to determine ways in which the shipyard could improve its operating procedures. Newport News managers believe that this program of market and technology research will pay off in coming years by improving the competitiveness of the firm and enhancing its ability to diversify into new markets. LIQUIFIED NATURAL GAS TANKER MARKET A cornerstone of the diversification effort has been a drive to enter the liquified natural gas (LNG) tanker market. LNG tankers began operating in the mid-1960s, and approximately 100 ships are currently in service worldwide. LNG tankers are extremely complex vessels, and

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force relatively few shipbuilders are capable of building them—only 12 yards in five countries have engaged in the construction of these tankers since 1980. They are also a very high-value-added product, typically costing $250 million, or three times the cost of a crude oil carrier of similar tonnage. Japanese companies are very prominent in this market (see Table B-1); however, managers at Newport News believe that their firm’s experience in building technologically advanced warships makes it well suited to the construction of LNG tankers as well. The high cost and complexity of LNG tankers is a result of the advanced containment systems necessary to transport liquified natural gas. The system must control the temperature of the cargo as well as the amount of natural gas that is allowed to “boil off” during transport. This gas is collected and used to power the ship. The four systems currently used in LNG tanker construction are the Technigaz Mark III system, the Gaz Transport system, the Kvaerner-Moss Spherical system, and the SPB system developed by Ishikawajima-Harima Heavy Industries (IHI). The Kvaerner-Moss Spherical system is the most widely used, equipping approximately half the world’s LNG tanker fleet. As Newport News prepared to reenter the LNG tanker market, however, it was primarily interested in IHI’s SPB system because of operational advantages and because its prismatic shape simplifies design and production, allowing ships to be produced at a lower cost. The liquified natural gas market itself is concentrated primarily among a few Asian and European countries. Japan is by far the largest importer, followed by France, Spain, Korea, Taiwan, and the United Kingdom. The United States also purchases significant amounts of LNG, but trade is considered less profitable because of domestic availability. The primary advantage of LNG for countries such as Japan is that it is a relatively clean fuel and is often used in power generation. The demand for LNG is closely correlated with the price of oil. In recent years the low price of crude oil has been a major factor in depressed demand for LNG and associated TABLE B-1 Nations Formerly and Currently Building Liquified Natural Gas Tankers   Yards Building LNG Tankersa Ships Constructedb Year of Last Delivery France 5 31 1994 Japan 5 28 1994 Republic of Korea 2 4 1994 United States 2 13 1980 Sweden 1 3 1984 Denmark 1 7 1977 Italy 1 2 1970 Belgium 1 1 1978 Germany 1 1 1977 Spain 1 1 1970 United Kingdom 1 1 1964 aIncludes yards that have built LNG ships in the past but no longer do so. bIncludes ships under construction or ships for which a contract has been awarded. SOURCE: Newport News Shipbuilding and Drydock Company.

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force transport systems. The major exporters of LNG are Algeria, Indonesia, Abu Dhabi, Malaysia, and Australia. Newport News has encountered obstacles in its efforts to become a force in the LNG tanker market. It is common practice for companies that have developed and own the major LNG transport systems to license their systems to other shipbuilders in order to gain income even on projects for which they are not building ships. However, in 1991-1992 IHI refused Newport News’ requests to license the SPB containment system. The stated reason was that IHI did not wish to license other shipbuilders until after the first two ships were delivered and the design was proven in service. By 1993, IHI had completed two tankers utilizing its SPB system. As an alternative to the SPB system, Newport News sought to license the Kvaerner-Moss Spherical system. Newport News intended to use the system in a competitive bid for a contract with the government of Qatar, which was seeking a greater role in the distribution of its liquified natural gas product. The shipyard received assurances from Kvaerner-Moss that the license would in fact be granted if Newport News won the contract, and it submitted a bid to Qatar on that basis. However, the Qatargas Shipping Team insisted that a license was required to be considered in the bidding. When Newport News then tried to secure a license, Kvaerner-Moss refused, saying that the U.S. shipbuilder should be able to prequalify without one. One factor in this situation might have been pressure from a Japanese consortium consisting of Mitsubishi Heavy Industries, Kawasaki Heavy Industries, and Mitsui Engineering and Shipbuilding, which had already licensed the Kvaerner-Moss system for the Qatar project. Qatar refused to consider Newport News ’ bid as long as it did not have a license from Kvaerner-Moss. With no alternatives, Newport News turned to the U.S. government for assistance. After high-level government contacts, the bid was finally allowed, but the competition was sufficiently advanced that Newport News had little chance of winning the contract. Newport News was not the only builder to be frozen out by the Japanese consortium in the Qatari LNG tanker competition. Despite its superior technology, IHI was unable to compete successfully against the larger group. A major advantage of the consortium was the large shipbuilding capacity that could be brought to bear, enabling it to deliver a given number of identical ships in a third of the time that an individual shipyard would take. In 1993, therefore, IHI decided to scrap its independent strategy for building global market share in LNG transport systems and informed Newport News of its willingness to license the SPB containment system and form a consortium that would also include Sumitomo Heavy Industries and Fincantieri, an Italian shipbuilder. IHI recognized several advantages in cooperating with Newport News following its failure in Qatar. Newport News’ large manufacturing capacity would increase the consortium’s competitive position in bids for future large LNG projects. IHI also perceived Newport News as having significant political influence with the U.S. government. It is likely that events in the Qatari competition, as well as previous instances of government assistance to large U.S. firms, led IHI to believe that a partnership with Newport News might allow it to benefit from such U.S. government involvement in the future.1 Aside from the strengths of Newport News, IHI found the financing packages that U.S. financial institutions are typically able to put together for projects of 1   For example, U.S. political leaders publicly supported U.S. commercial aircraft manufacturers in Saudi Arabia’s recent purchase. Some have observed that in the wake of the Persian Gulf War such influence by high-level U.S. officials could be expected to be greatest with Middle Eastern nations, which produce much of the world’s LNG, and are increasingly influential in transport system decisions because of their interest in vertical integration.

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force this type very attractive.2 Finally, a consortium that included a large U.S. partner would be well positioned to compete in the U.S. market should it improve. Newport News found the arrangement equally appealing. Most importantly, the firm gained access to advanced Japanese LNG containment technology. The terms of the arrangement allow Newport News to use the SPB system on any contract, whether doing so as part of the consortium or as an independent builder. Participation in the consortium, however, will improve the firm’s competitive position—particularly in large projects—by allowing it to deliver larger numbers of identical ships more quickly. Finally, the association with IHI has allowed Newport News to assimilate advanced Japanese shipbuilding techniques that hold long-term potential for improving the efficiency of its operations, better enabling it to compete in commercial shipbuilding markets. Newport News reports that IHI has been very open about sharing insights about its manufacturing processes. Implementing some of these techniques will require significant capital investments, but lessons learned from IHI and other global shipyards will help Newport News adopt the most cost-effective and appropriate manufacturing technologies as it works to expand its commercial business in coming years. FUTURE PROSPECTS Since Newport News has not yet won a contract utilizing the license from IHI—either by itself or as part of the consortium with IHI and the other yards—it is impossible to assess the bottom-line benefits of the relationship at this point. Certainly, the company’s prospects in competition for future LNG projects are considerably enhanced as a result of its unrestricted access to IHI’s SPB technology. The case is a promising example of how U.S. defense contractors might leverage international technological capabilities in order to diversify and address commercial markets. The evolution in IHI’s strategy may also be a harbinger of more general shifts in the international strategic alliance approaches of Japanese firms, which have traditionally been eager to enter alliances that enhance their technological capabilities but have been reluctant to share their own technologies. The experience with the Qatar bid showed IHI that a “go it alone” strategy is not feasible in the global market environment for LNG transport systems that is likely to prevail in coming years. The growing need for Japanese companies to reduce manufacturing costs brought about by the long-term appreciation of the yen and fierce global competition—including competition between groups of Japanese companies—might lead to more U.S.-Japan business alliances in which technology flows from Japan to the United States. If such a trend does indeed materialize, it could only help the overall environment for U.S.-Japan relations. MARINE SYSTEMS TECHNOLOGY PROGRAM The Newport News-IHI relationship has been further strengthened by their joint involvement in the Marine Systems Technology (MARITECH) program, which was initiated in 1993 to 2   This might be counterintuitive to some, because Japanese companies have traditionally enjoyed access to relatively inexpensive capital. American financial institutions, however, are very competitive in financing large projects because of their experience in the financial engineering that such projects often entail.

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force revitalize the U.S. commercial shipbuilding industry. Administered by DoD’s Advanced Research Projects Agency (ARPA), MARITECH functions much like the Technology Reinvestment Project. Firms submit proposals for projects to ARPA, and ARPA supplies matching funds to those deemed best able to contribute to the advancement of relevant technologies. Funding for 1994 was $30 million, with another $190 million allocated through 1998. Presently, the United States is virtually absent from commercial shipbuilding markets. Although the U.S. position had been declining for many years, the erosion accelerated during the 1980s as U.S. military demand rose, U.S. government subsidies for commercial shipbuilding were eliminated while the subsidy programs of other nations expanded, and the worldwide demand for ocean-going commercial vessels fell. 3 With the sharp decline in U.S. Navy procurement of ships in the aftermath of the Cold War, U.S. policymakers realized that U.S. reentry into international commercial shipbuilding markets would be necessary in order to maintain the military shipbuilding industrial base, important both in terms of production capacity required for surge contingencies and sufficient infrastructure for future technology development. The MARITECH program is part of an overall strategy to enhance U.S. competitiveness in commercial shipbuilding. The strategy also incorporates financing and marketing assistance, as well as a focus on leveling the international competitive playing field through trade policy. MARITECH seeks to improve the competitiveness of U.S. shipbuilders by fostering the creation of technologies that will help American shipyards produce commercial vessels more quickly and profitably. The emphasis is on helping firms advance beyond their current methods of operation, shaped by years of dependence on government contracts, and develop more proactive, market-oriented approaches to ship design, product development, construction, and international marketing. In an effort to ensure the near-term survival of U.S. shipbuilding firms, early MARITECH funding will be heavily invested in production-oriented, market-driven projects that can be implemented in two to three years. An international partnership led by Newport News received $3 million in MARITECH funding in fiscal year 1994. Designed to facilitate the company’s conversion to a world-class commercial shipbuilder, the project entails the design of a 40,000-dead-weight-ton tanker using comprehensive market analysis, advanced production processes, and revised project management. IHI is one of eight partners in the project. Foreign participation is common among groups receiving MARITECH funding; 16 of the 20 projects receiving MARITECH awards in 1994 included at least one foreign firm. ARPA encourages foreign participation as many of the advanced technologies and production techniques needed to improve the efficiency of U.S. shipbuilders are found in foreign yards. Given the strong position of the Japanese commercial shipbuilding industry, Japanese companies are prominent among the foreign participants —nine of the 20 MARITECH projects funded for 1994 include Japanese firms, with IHI participating in four and Kawasaki Heavy Industries participating in three (see Table B-2). MARITECH represents a significant experiment in U.S. technology policy. The program fits with the overall recent movement toward expanded U.S. government support for commercial technology development through a variety of government-industry partnerships. ARPA’s Technology Reinvestment Project and the Advanced Technology Program of the U.S. 3   See papers prepared by Charles E. Stuart, Robert Schaffran, and Donald Fraser, “MARITECH: Shipbuilding Technology for Commercial Competitiveness,” November 1993.

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force TABLE B-2 Marine Systems Technology (MARITECH) Program Awards with Japanese Participation, Fiscal Year 1994 Project Number of Partners Primary Awardee Japanese Partners Federal Funding, $ million 23,000-ton container/ bulk carrier 2 Halter Marine Ishikawajima–Harima Heavy Industries (IHI) 1.0 Multipurpose cargo ship design/ process development 5 McDermott IHI 3.9 U.S.-built cruise ships—designs for the world market 6 National Steel and Shipbuilding Kawasaki Heavy Industries (KHI) 0.4 Integration of modern manufacturing methods 2 Todd Pacific Shipyards Maritech Engineering Japan Co. 1.6 Focused technology development 10 Avondale Industries Mitsubishi Heavy Industries 2.3 Petroleum product tanker development 13 Gibbs & Cox IHI 0.8 Market and producibility–driven tanker design 9 National Steel and Shipbuilding KHI 0.2 Conversion to a world–class commercial shipbuilder 8 Newport News Shipbuilding IHI 3.0 Internationally competitive ships for the 1990s 3 National Steel and Shipbuilding KHI; Kawasaki Kisen (K-Line) 0.2 SOURCE: U.S. Department of Defense, Advanced Research Projects Agency. Department of Commerce are the most prominent examples of this approach. MARITECH is unique among these in that it targets an industry—commercial shipbuilding—from which the United States has been almost completely absent for a number of years. This contrasts with the SEMATECH semiconductor manufacturing consortium that ARPA launched with a number of U.S. semiconductor companies in the late 1980s. The U.S. semiconductor industry, while facing significant challenges, particularly from Japan, still held a large share of the world market when SEMATECH was launched. Since MARITECH is part of a strategy to facilitate U.S. reentry into an industry with entrenched technologically advanced international competitors, success will require that U.S. companies access and effectively utilize technological capabilities from around the world, including Japan. MARITECH may represent the only U.S. government technology

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Maximizing U.S. Interests in Science and Technology Relations with Japan: Report of the Defense Task Force policy initiative that implicitly encourages foreign participation of this type—an open approach required by the circumstances. Just as success is not assured for Newport News-IHI alliance in LNG tankers, there is no guarantee that the MARITECH program as a whole or the individual projects involving Japanese companies will succeed in revitalizing U.S. commercial shipbuilding capabilities. A favorable market environment for the remainder of this decade may represent a critical window of opportunity, since the demand for various types of commercial ships is projected to rise significantly. Japan’s high production costs and growing competition with Korean and other shipbuilders may lead to expanded opportunities for U.S.-Japan alliances that produce long-term, mutual benefits. In light of the DoD’s recent efforts to pursue a more reciprocal U.S.-Japan exchange of technologies through the Technology-for-Technology initiative, and U.S. government technology policies more broadly, the MARITECH experiment should perhaps be studied closely as the results become more clear over the next several years. As an existing program in which the DoD is facilitating transfer of Japanese and other foreign technologies to build the dual-use capabilities of U.S. companies, it could serve as a model for future initiatives to the extent that it succeeds.